S.I.F. Italia's (BIT:SIF) Earnings Are Built On Soft Foundations

Solid profit numbers didn't seem to be enough to please S.I.F. Italia S.p.A.'s (BIT:SIF) shareholders. We think that they might be concerned about some underlying details that our analysis found.

View our latest analysis for S.I.F. Italia

Zooming In On S.I.F. Italia's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2022, S.I.F. Italia recorded an accrual ratio of 0.44. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of €1.90m, a look at free cash flow indicates it actually burnt through €675k in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of €675k, this year, indicates high risk. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of S.I.F. Italia.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, S.I.F. Italia increased the number of shares on issue by 18% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of S.I.F. Italia's EPS by clicking here.

How Is Dilution Impacting S.I.F. Italia's Earnings Per Share (EPS)?

We don't have any data on the company's profits from three years ago. On the bright side, in the last twelve months it grew profit by 24%. On the other hand, earnings per share are only up 57% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So S.I.F. Italia shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On S.I.F. Italia's Profit Performance

In conclusion, S.I.F. Italia has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. Considering all this we'd argue S.I.F. Italia's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that S.I.F. Italia has 4 warning signs (1 is a bit unpleasant!) that deserve your attention before going any further with your analysis.

Our examination of S.I.F. Italia has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.